Is China Still Safe for Investors?

Domestic and international problems abound in the world's second-largest economy.

China's been the hottest topic in international investing for quite some time. The world's second-largest economy has risen to the pinnacle of global power, a beast with a massive population and swelling middle class that many have predicted to challenge the United States' economic leadership for decades to come. For investors, the story's more complicated: While China's rise has done wonders for the nation, it hasn't always rewarded stock portfolios.

That's not the only danger to Chinese investing, however. The country's economy is on anything but stable footing, and while China should continue to rise, its era of high growth could be coming to a halt. Chinese markets have underperformed other world indexes this year, with Hong Kong's Hang Seng(HSIINDICES:^HSI) index losing 6.3% year to date while American, Japanese, and even some European indexes have skyrocketed. Is China still friendly to investors, or is the world's growth story no longer a safe bet for your money?

Cold trade winds blowingChina's facing more risks than just a disappointing stock market. The country's manufacturing sector has fallen from its earlier highs. HSBC's China PMI showed the country's reading at 49.2, placing it in contraction territory and falling far below April's slight expansion. With China's middle class rapidly growing, cities and infrastructure in need of improvement, a decline in manufacturing won't help this country's growth pick up to the double-digit percentages seen as recently as 2010.

Analysts have taken note. The International Monetary Fund recently lowered China's growth outlook for the year to 7.75% from an earlier 8%, which would mean an even slower advance from last year's 7.8% figure. Considering China's support of state-owned enterprises that have advanced relatively little innovation, future growth could fall even further -- a bad sign for investors hoping for companies to capitalize on any Chinese rebound.

More concerning from May's PMI is China's export situation. For a long time, China has relied on strength in trade to fuel its boom. Export orders fell for the second straight month in May, however. China reported a massive trade surplus of more than $60 billion for the year so far, but analysts have estimated that number to be severely inflated, with China's real surplus as low as perhaps a tenth of that figure. That'd mark further contraction from 2012's trade surplus, and with cheap manufacturing fleeing China, the nation will be hard-pressed to continue relying on trade for growth in the future.

That problem's grown even worse considering China's aggressive stance against trade partners recently. The country's well-publicized spat with Japan over the disputed Senkaku Islands dominated headlines earlier in the year. The nation's also sparred with Asian neighbors over claims in the South China Sea, and China's biggest stocks could be negatively affected by its aggressive action toward its fellow Asian states. China's diminishing trade surplus could also fall from that action.

The issue's expanded beyond Asia, however, into something that could seriously harm Chinese business interests. After the European Union deployed tariffs on solar panels in response to concerns over Chinese dumping tactics, China's government answered by levying its own tariffs on European wines. The danger to Chinese solar firms is obvious, but a long-term trade war with Europe threatens the success of even some of China's largest firms.

European automakers have expressed concern that an escalating trade war could impact sales. While such an incident could open up both regions to stronger sales from U.S. companies, how long will it be until the U.S. and China -- two nations that can hardly be called friends -- engage in a similar back-and-forth action? Any American-Chinese trade war, while purely speculative at this point, could seriously dent major U.S. firms, particularly in the struggling industrials sector that has come to view China as a major part of its future plans.

China's not a dead end for investors just yet, but concerns over this country's future are growing rapidly. From its slowdown that refuses to go away to its spats with neighbors and declining trade buffer, China will have to confront a myriad of problems if it wants to thrive economically over the long term. For investors, it's a risky bet. Invest with caution.